Mergers and Acquisitions: What Management Teams Want to Know From a Prospective M&A Acquirer

By Richard D. Harroch and Richard V. Smith

In any merger and acquisition (M&A) transaction, the seller’s senior management team is charged with maximizing the price and terms available to the shareholders of the selling company. Taking their direction from the Board of Directors—and with the assistance of the selling company’s legal and financial advisors—the senior management team is instrumental in landing and negotiating a deal that’s in the best interests of the company and its shareholders.

The management team should be aware of the key issues that will arise in attempting to get to a successful completion of an M&A deal.

If they are to continue on with the buyer, the members of the management team will also naturally have a number of questions as to how the buyer will treat the team post-closing with respect to compensation and employment incentive arrangements. Some of these questions will vary if the buyer is a private equity fund versus a strategic buyer. However, in order to avoid a potential conflict of interest claim, members of the management should be sensitive to the issue of when to ask some of their questions.

The following is a list of the key questions that the management team of a seller should consider in connection with a sale of their company.

1. Business Continuation and Strategic Plan Issues

The management team will want to understand the strategic plans the buyer is envisioning for the company, including:

What is your overall strategic reason for the acquisition?
How do you plan to support and grow the business?
How do you plan to integrate the business with your other businesses?
Do you envision any acquisitions to grow the business?
What synergies do you see with your existing lines of business?
How do you like to work with your management teams?
What existing or new lines of the business do you see as ripe for growth?
What areas of the business do you envision cutting back or eliminating?
How long do you plan to hold the business before contemplating reselling it or taking it public?
What layoffs do you envision, if any?
What additions to the management team do you envision?
Will you allow us to speak with the management teams of companies you previously acquired?

2. M&A Deal Issues

Senior members of management teams of selling companies want to obtain an early understanding of the deal dynamics and key issues involved in a potential acquisition. Some of the key questions that management will likely be interested in include:

What acquisition structure are you contemplating? (Stock acquisition, merger, asset purchase? There will be differing tax consequences)
What is the range of acquisition price you are considering?
How do you determine valuation for your acquisitions?
Are you envisioning any working capital or other adjustments to the purchase price? Debt-free/cash-free deal?
What will be the consideration? (Cash, stock, note, or earnout?
Are you envisioning any escrow or holdback from the purchase price, or will you instead rely on M&A Representations and Warranties Insurance?
What are the key due diligence steps you will need to undertake?
How long will you need to complete your due diligence?
What are the key conditions to closing that you envision?
What employee interviews do you envision?
Do you envision any customer calls?
When do you anticipate issuing a letter of intent?
How long do you expect it to take between signing a definitive acquisition agreement and closing?
Will there be any particularly sensitive provisions to our shareholders in your acquisition agreement?
What will be the key steps for integration post-closing?
How will our employee workforce be treated? Will comparable compensation and benefits be available to them post-closing?
Do you have any key intellectual property or technology issues you will be focusing on?

3. Equity Incentive Arrangements

Smart strategic or private equity buyers know they have to put in place equity incentive arrangements for the management team and employees. The key questions management teams will have in this regard include:

What kind of equity incentive plans do you envision? Stock options? RSUs? Stock appreciation rights? Profits interests? Or something else? How will the plan work?
If the acquirer is a private equity fund, will the acquirer require a management rollover investment of a portion or all of the equity the management team holds in the selling company? Will the acquirer allow or require management to rollover all or a substantial portion of its equity? Will the rollover be tax free? Will any of the rolled-over equity be subject to forfeiture?
In such a rollover, how will the new investment vehicle be governed? What type of rights will the rollover holders have with respect to important actions and transactions which affect their interests in the new investment vehicle?
If the equity grant consists of stock options, what will be the exercise price? How can this be as low as possible to give more upside to the option holder?
If there will be stock options, will the holder be able to exercise the options pursuant to a “cashless exercise” and avoid the need to come up with cash to exercise the option?
What percentage of the fully diluted capitalization of the company will be available for the equity incentive plan? (10% to 15% is typical)
What specific percentages of the equity incentive plan do you envision being allocated to individual key team members? Which key team members will be allocated equity?
How will vesting of the equity work? Over what period of time? (Three- or four-year vesting is typical, but performance vesting for a portion may also be built in).
Will the vesting be accelerated partially or in full on a change of control of the business?
Will the vesting be accelerated for some or all of the grant on termination of employment of an executive without cause?
What dilution to the team’s equity could occur over time?
What tax treatment will be expected for the management team of the equity grant upon a sale? Can it be structured to get capital gains treatment, such as via a profits interest in an LLC?
How long does the executive have to exercise options after termination of employment? (The typical period is 90 days, but this is negotiable and can vary depending on whether the termination is for cause, not for cause, or voluntary quitting by the executive to accept another job.)
Are the shares obtained upon exercise of an option subject to repurchase on termination of employment? If so, at what price?
Are the shares obtained upon exercise of an option subject to a right of first refusal? If so, on what terms?
How can the executive get liquidity on the equity in the future, without necessarily waiting for an M&A exit? Will the executive have a right to “put” his or her shares at fair market value to the company for purchase, and, if so, when? How will the fair market value purchase price be determined? (The fair market value is often determined by an outside appraiser who is required to ignore any discount on fair market value because of lack of control, liquidity, or transferability for the shares.)
Will there be “drag-along” provisions forcing the executive to sell his or her shares in a subsequent M&A event? Will those shares be treated fairly along with other shares being sold?

4. Employment Agreement Issues

The buyer may want to put in place an employment agreement for the CEO and some members of the senior management team. From the perspective of such an executive, here are the key issues to be addressed. (It’s beneficial for these executives to request to see the form of employment agreement early, and then have experienced employment counsel review and negotiate the agreement on their behalf.):

Scope of employment provisions

The scope of the employment and responsibilities raise a number of issues:

What is the title of the executive’s job?
What are the executive’s responsibilities?
Can the executive be demoted? Can the executive’s responsibilities be substantially modified, decreased, or increased?
Is the executive guaranteed a seat on the Board of Directors while an executive? (Typically, this only applies to the CEO.)
Where is the place of employment?
Can the executive be relocated unilaterally to another city more than 25 miles away, or only with the executive’s consent?
Is the executive allowed to be involved in other activities (e.g., a directorship on other Boards, involvement in community activities or non-profits)?

Compensation issues

What is the base salary?
Does the base salary increase each year of the contract?
What quarterly or annual bonus is available? Is the bonus guaranteed, dependent on achievement of milestones, or wholly discretionary with the Board of Directors?
Under what circumstances, if any, can the executive’s base salary be reduced?

Benefits issues

The various employee benefits available to an executive can raise a number of issues, including:

Will the executive participate in all of the benefit plans of the company?
Which of these plans should be in place for the executive? Are all of the payments for the benefits the responsibility of the company?

(a) Health and medical (including spouse and dependent coverage)

(b) Disability

(d) Pension

(e) Cafeteria Plan

(f) Life insurance

(g) Stock option/stock grant

(h) Vision

(i) Dental

(j) Executive financial counseling

How much vacation per year is the executive entitled to? Does unused vacation continue to accrue for the benefit of the executive and is payable on termination of employment?
How much accrued vacation can carry over to subsequent years?
Are there any special loans or forgiveness arrangements?
Are some of the benefits taxable to the executive? Should the executive be reimbursed for the tax?

Term and termination issues

The circumstances in which the executive’s employment can be terminated and the resulting consequences will raise the following issues:

How long is the employment term or is the employment “at will”?
What are the grounds on which the company can terminate the executive?
What are the circumstances that the executive can be fired “for cause,” and how is “cause” defined? It is in the executive’s best interest to have a narrow definition of “cause,” such as:

– Felony conviction or any act involving moral turpitude;

– Material breach of the employment agreement after an opportunity to cure has been given

Is the executive entitled to severance pay on termination without cause? How much? Is it a lump sum or payable over time? (The typical arrangement for a senior executive is at least one year of severance, payable in a lump sum upon termination.)
If terminated without cause, is the company required to continue paying for benefits or COBRA benefits for some period of time?
May the executive terminate his or her employment (and receive severance payments) for “good reason,” such as change in responsibilities, compensation, or location of employment?
If the executive is to receive a severance payment, the executive will typically be required to sign a release of liability for the benefit of the company, but the executive will want to negotiate this to be a mutual release.

Reimbursement of expenses

The issues regarding the right of the executive getting reimbursement of expenses include:

Will the executive’s business expenses be reimbursed within a set time period?
Is there a car or car allowance, cell phone provided, or other such amenities?
Is there a relocation package available for the executive should relocation be necessary?
Will the executive be reimbursed for any attorney’s fees incurred in negotiating the employment agreement, or will the company pay those fees directly?

Liability protection for the executive

The executive may want to negotiate certain liability protection mechanisms, covering the executive performing services within the scope of employment:

Will the company have Directors’ and Officers’ (“D&O”) insurance coverage?
Will the company Bylaws provide for indemnification protection for officers and executives?
Will the company’s corporate charter limit the liability of officers and directors to the maximum extent permitted by law?
Will there be an Indemnification Agreement that protects the executive, covering:

(a) Indemnification protection for claims

(b) Automatic advancement of legal expenses

(c) Protection even if the executive is no longer employed by the company? (Note statutory limitations on indemnification.)

Confidentiality restrictions

The employer will want confidentiality provisions in the Employment Agreement:

Many companies have a separate form of employer Confidentiality and Invention Assignment Agreement that can be incorporated by reference.
The executive must be careful not to use or divulge confidential information of a prior employer—the new employer will often want a covenant from the executive prohibiting such use or disclosure.
If there are confidentiality restrictions on the executive, are the following excluded from the definition of “confidential information”?:

(a) Information that is or was publicly known, or which becomes publicly known through no fault of executive

(b) Information that is or was obtained from a third party who had the right to disclose the information without restriction

(d) Information that was already lawfully in executive’s possession or knowledge prior to the disclosure of the confidential information

Invention Assignment issues

Companies expect that any inventions or business ideas developed by the executive related to the company’s business during the employment period will be owned by the company:

What is the scope of the company’s rights to the executive’s development of new inventions, trade secrets, and ideas?
Do the invention assignment provisions comply with applicable laws?

Disability and death issues

Various issues arise on the death or disability of the executive:

What is defined as a disability event?
What happens on disability? Does the executive continue to receive salary and benefits for some period of time?
What happens on death? Can medical and other benefits continue for some period for any spouse or children?

Post-employment limitations

The Employment Agreement can address various limitations on the executive after termination of employment:

Are there limitations on the executive soliciting company executives? For what period?
Is there a covenant not to compete after termination of employment? Many executives will strongly object to such a provision, on the theory that it adversely affects their future livelihood. If there is such an agreement, the terms are key, and executives should attempt to narrow the terms on the following issues:

(a) For what geographic regions?

(b) For what period?

(d) Are the restrictions enforceable under applicable law? (Generally not permitted in California, but usually enforceable to the extent reasonable under the laws of certain other states such as New York and Delaware.)

Tax issues

Tax issues can materially impact the compensation and benefits available to an executive. Key questions to ask include:

How can tax consequences be minimized?
How can IRS 280G golden parachute issues be minimized?
Is there some appropriate tax-deferred compensation scheme that can be implemented?

Dispute resolution

Most Employment Agreements have provisions dealing with disputes between the company and the executive:

How are disputes resolved?
Should confidential binding arbitration be the exclusive way to resolve disputes? (This is the preferred mechanism from the executive’s standpoint.)
In what city must disputes be brought if litigated or arbitrated?
What is the governing law?

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About the Authors

Richard D. Harroch is a Managing Director and Global Head of M&A at VantagePoint Capital Partners, a large venture capital fund in the San Francisco area. His focus is on Internet, digital media, and software companies, and he was the founder of several Internet companies. His articles have appeared online in Forbes, Fortune, MSN, Yahoo, FoxBusiness, and AllBusiness.com. Richard is the author of several books on startups and entrepreneurship as well as the co-author of Poker for Dummies and a Wall Street Journal-bestselling book on small business. He is the co-author of the recently published 1,500-page book by Bloomberg, Mergers and Acquisitions of Privately Held Companies: Analysis, Forms and Agreements. He was also a corporate and M&A partner at the law firm of Orrick, Herrington & Sutcliffe, with experience in startups, mergers and acquisitions, and venture capital. He has been involved in over 200 M&A transactions and 250 startup financings. He can be reached through LinkedIn.

Richard V. Smith is a partner in the Silicon Valley and San Francisco offices of Orrick, Herrington & Sutcliffe LLP, and a member of its Global Mergers & Acquisitions and Private Equity Group. He specializes in the areas of mergers and acquisitions, corporate governance and activist and takeover defense. Richard has advised on more than 500 M&A transactions and has represented clients in all aspects of mergers and acquisitions transactions involving public and private companies, corporate governance, and activist and takeover defense. He is the co-author of the recently published 1,500-page book by Bloomberg, Mergers and Acquisitions of Privately Held Companies: Analysis, Forms and Agreements and numerous articles on mergers and acquisitions and corporate governance matters. He can be reached through LinkedIn.

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